Tag Archives: Business Tax

How to Manage the Limit on the Business Interest Expense Deduction

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Prior to the enactment of the Tax Cuts and Jobs Act (TCJA), businesses were able to claim a tax deduction for most business-related interest expense. The TCJA created Section 163(j), which generally limits deductions of business interest, with certain exceptions.

If your business has significant interest expense, it’s important to understand the impact of the deduction limit on your tax bill. The good news is there may be ways to soften the tax bite in 2025. Keep reading for tips on how to manage the limit on the business interest expense deduction.

Details on Business Interest Deductions

Unless your company is exempt from Sec. 163(j), your maximum business interest deduction for the tax year equals the sum of:

  • 30 percent of your company’s adjusted taxable income (ATI),
  • Your company’s business interest income, if any, and
  • Your company’s floor plan financing interest, if any.

Assuming your company doesn’t have significant business interest income or floor plan financing interest expense, the deduction limitation is roughly equal to 30 percent of ATI.

Your company’s ATI is its taxable income, excluding:

  • Nonbusiness income, gain, deduction or loss,
  • Business interest income or expense,
  • Net operating loss deductions, and
  • The 20 percent qualified business income deduction for pass-through entities.

When Sec. 163(j) first became law, ATI was computed without regard to depreciation, amortization, or depletion. But for tax years beginning after 2021, those items are subtracted in calculating ATI, shrinking business interest deductions for companies with significant depreciable assets.

Deductions disallowed under Sec. 163(j) may be carried forward indefinitely and treated as business interest expense paid or accrued in future tax years. In subsequent tax years, the carryforward amount is applied as if it were incurred in that year, and the limitation for that year will determine how much of the disallowed interest can be deducted. There are special rules for applying the deduction limit to pass-through entities, such as partnerships, S corporations, and limited liability companies that are treated as partnerships for tax purposes.

Small businesses are exempt from the business interest deduction limit. These are businesses whose average annual gross receipts for the preceding three tax years don’t exceed a certain threshold. (There’s an exception if the business is treated as a “tax shelter.”) To prevent larger businesses from splitting themselves into small entities to qualify for the exemption, certain related businesses must aggregate their gross receipts for purposes of the threshold.

Ways to Avoid the Limit

Some real estate and farming businesses can opt out of the business interest deduction limit and therefore avoid it or at least reduce its impact. Real estate businesses include those that engage in real property development, redevelopment, construction, reconstruction, acquisition, conversion, rental, operation, management, leasing, or brokerage.

Remember that opting out of the interest deduction limit comes at a cost. If you do so, you must reduce depreciation deductions for certain business property by using longer recovery periods. To determine whether opting out will benefit your business, you’ll need to weigh the tax benefit of unlimited interest deductions against the tax cost of lower depreciation deductions. We can help with that.

Another tax-reduction strategy is capitalizing interest expense. Capitalized interest isn’t treated as interest for purposes of the Sec. 163(j) deduction limit. The tax code allows businesses to capitalize certain overhead costs, including interest, related to the acquisition or production of property.

Interest capitalized to equipment or other fixed assets can be recovered over time through depreciation, while interest capitalized to inventory can be deducted as part of the cost of goods sold. We can crunch the numbers to determine which strategy would provide a better tax advantage for your business.

You may also be able to mitigate the impact of the deduction limit by reducing your interest expense. For example, you might rely more on equity than debt to finance your business or pay down debts when possible. Or you could generate interest income (for example, by extending credit to customers) to offset some interest expense.

Weigh Your Tax Options

Unfortunately, the business interest deduction limitation isn’t one of the many provisions of the Tax Cuts and Jobs Act scheduled to expire at the end of 2025. But it’s possible that Congress could act to repeal the limitation or alleviate its impact. If your company is affected by the business interest deduction limitation, contact us to discuss the impact on your tax bill. The business tax professionals at Ramsay & Associates can help assess what’s right for your situation.

About the author

Brady is the owner of Ramsay & Associates. He specializes in financial statement preparation and personal, fiduciary and corporate tax and accounting.

His professional experience includes seven years' experience for local and national CPA firms before joining Ramsay & Associates in 2006.

He has a Bachelor of Accounting degree from the University of Minnesota Duluth. He is a Certified Public Accountant, a member of the Minnesota Society of CPA's, an Eagle Scout, as well as an active volunteer in the community.

Tax Details When Selling Trade or Business Property

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If you’re selling trade or business property, be aware that there are many tax rules that can potentially apply to such transactions. To simplify discussion, let’s assume that the property you want to sell is land or depreciable property used in your business. And let’s also assume it has been held by you for more than a year. (There are different rules for property held primarily for sale to customers in the ordinary course of business; intellectual property; low-income housing; property that involves farming or livestock; and other types of property.) We can help ensure you know the rules and consequences.

General Rules

Under the Internal Revenue Code, your gains and losses from sales of business property are netted against each other. The net gain or loss qualifies for tax treatment as follows:

  1. If the netting of gains and losses results in a net gain, then long-term capital gain treatment results, subject to “recapture” rules discussed below. Long-term capital gain treatment is generally more favorable than ordinary income treatment.
  2. If the netting of gains and losses results in a net loss, that loss is fully deductible against ordinary income. (In other words, none of the rules that limit the deductibility of capital losses applies.)

Recapture Rules

The availability of long-term capital gain treatment for business property net gain is limited by “recapture” rules. These are rules under which amounts are treated as ordinary income rather than capital gain because of previous ordinary loss or deduction treatment for these amounts.

There’s a special recapture rule that applies only to business property. Under this rule, to the extent you’ve had a business property net loss within the previous five years, any business property net gain is treated as ordinary income instead of as long-term capital gain.

Section 1245 Property

“Section 1245 Property” consists of all depreciable personal property, whether tangible or intangible, and certain depreciable real property (usually, real property that performs specific functions). If you sell Section 1245 Property, you must recapture your gain as ordinary income to the extent of your earlier depreciation deductions on the asset.

Section 1250 Property

Generally speaking, “Section 1250 Property” consists of buildings and their structural components. If you sell Section 1250 Property that was placed in service after 1986, none of the long-term capital gain attributable to depreciation deductions will be subject to depreciation recapture.

However, for most noncorporate taxpayers, the gain attributable to depreciation deductions, to the extent it doesn’t exceed business property net gain, will (as reduced by the business property recapture rule above) be taxed. That gain will be taxed at a rate of no more than 28.8% (25% as adjusted for the 3.8% net investment income tax) rather than the maximum 23.8% rate (20% as adjusted for the 3.8% net investment income tax) that generally applies to long-term capital gains of noncorporate taxpayers.

Other rules may apply to Section 1250 Property, depending on when it was placed in service.

Understanding the Consequences

As you can see, even with the simplifying assumptions in this article, the tax treatment of the sale of business assets can be complex. To further understand the tax details when selling trade or business property, contact the business tax professionals at Ramsay & Associates. We can help determine the tax consequences of specific transactions or answer any additional questions.

About the author

Brady is the owner of Ramsay & Associates. He specializes in financial statement preparation and personal, fiduciary and corporate tax and accounting.

His professional experience includes seven years' experience for local and national CPA firms before joining Ramsay & Associates in 2006.

He has a Bachelor of Accounting degree from the University of Minnesota Duluth. He is a Certified Public Accountant, a member of the Minnesota Society of CPA's, an Eagle Scout, as well as an active volunteer in the community.